Inflation v. Civilization; Frances Cairncross Puts Questions to Professor Milton Friedman, Arch-exponent of Monetarism Milton Friedman interviewed by Frances Cairncross Guardian, 21 September 1974, p. 15 Guardian News & Media Ltd. 1974 Francis Cairncross: Professor Friedman, in recent years, we have seen an acceleration in inflation all over the world. What has caused that? Milton Friedman: Every country in the world in the past 20 years has increasingly resorted to the printing press, either to finance Government spending, or to promote full employment. This has produced a common result. There has been a steady trend in most Western countries towards a more rapid rate of monetary expansion. Cairncross: But hasn t world inflation suddenly accelerated? Friedman: Not really. Public awareness of what has been going on has increased and the lag between monetary expansion and its manifestation in the form of price rises has become shorter. Cairncross: Why do you think Governments have followed policies that have proved to be inflationary? Friedman: For three reasons: one is thousands of years old and has been the source of almost every inflation in history. Cairncross: What is that? Friedman: Inflation is the one form of taxation that can be imposed without legislation. It is also a form of taxation that is particularly seductive. In its early stages, people find it rather attractive, because the first effects of inflation are expansionary and pleasant. It s like the first drink you take. It s only the next morning that you have a hangover. Cairncross: But the Government only imposes it because its electors demand it? Friedman: That s right. The same people in Britain, who protest most vigorously against inflation, have also been the most vigorous in urging their MPs to vote for higher welfare benefits, more spending on housing and so on. More than a century ago the French economist, Frederic Bastiat, said: Government is that fiction whereby everybody thinks he can live at the expense of everybody else. If your constituents are urging you to spend more money and if at the same time they object strenuously to your raising explicit taxes, then you have to impose the hidden tax of inflation. It s a particularly vicious, a particularly destructive tax. But it is an effective way of raising revenue. Cairncross: What s the second reason why the Governments inflate? Friedman: It is a new one. It is the Keynsian heritage of Government commitment to full employment. It is the reaction of the public at large to the great depression of 1929 33 in the 1
United States, and of the long period of high unemployment in the 1920s in Great Britain. There has been greater public concern and fear about unemployment than there has been about inflation. Typically, inflation has begun because the Government has printed more money. At first, this has led to higher employment. But then people have become worried about inflation. The Government and the monetary authorities have tried to stop it. At once, there has been a public outcry. So the policy has been reversed the Government begins spending more money. A higher and higher rate of inflation has been produced by over-reaction to transitory recessions. Cairncross: What s the third reason? Friedman: The mistake of central bankers, who have confused money with credit and have taken their task to be to hold down interest rates, rather than to prevent unduly rapid growth in the quantity of money. Paradoxical though it may seem, today s high interest rates are a consequence of the attempt by central bankers to hold down interest rates. They have been able to do so temporarily by rapid monetary growth that has produced inflation, that, in turn, has raised interest rates to historically unprecedented levels. Cairncross: Don t you think that droughts and bad harvests and the oil producers cartel, also have some effect on inflation? Friedman: No. I believe that s an excuse and not a reason. The oil producers cartel has contributed to making us all poorer. It reduced our real incomes. If you spend more on oil, doesn t that leave you less to spend on something else? Why don t other prices come down, or not rise as rapidly? It s a complete fallacy to suppose that the rise in the price of oil, or of other commodities, has had any significant effect on inflation. Cairncross: What do you see happening in the future? Will inflation continue to accelerate? Friedman: I don t believe the answer will be the same in every country. The prospects are much better for Japan and Germany than they are for most other countries. They are most likely to have the public opinion that will support the kind of measures needed to slow down inflation. Cairncross: What about the United States and the United Kingdom? Friedman: In both countries I have the impression that the public is ahead of its leaders. We re getting farther and farther away from the bad old days of high unemployment and having more and more experience of the bad old present of inflation. But in neither of our countries has the political reaction against unemployment lost its sting. In neither has the political reaction against inflation gained enough momentum. If I have to make a guess, I think the present, very high rate of inflation will taper off, both in your country and in mine. In the United States, the rate of inflation will come down fairly sharply in the next year, or two. But that will not be a permanent change. As soon as it begins coming down, people will forget their concern about high rates of inflation and begin worrying about the moderate rates of unemployment that will accompany the slowdown. The odds are we shall then be off on another of these cycles. 2
Cairncross: Do you think an incomes policy is an essential adjunct of a strict monetary policy? Friedman: Not at all. Cairncross: Why? Friedman: Incomes policy is part of the disease and not of the cure. As I see it the fundamental argument for an incomes policy is that inflationary expectations get built into wage bargaining and into pay contracts. So, when you try to slow down inflation you are stuck with real wages into which a higher inflationary expectation is embedded. The supporters of incomes policy say: Let s cut this short at the beginning, by not letting money wages level go up. We can then have the same real wages as we would have, but on a lower price level. If that argument is valid, it s an argument for indexing wages. Cairncross: The ultimate justification for an incomes policy, surely, is that if we have to pay a price for curing inflation then the price should be shared equally among the weak and the strong. Friedman: Is it really a valid argument for incomes policy that it enables you to reduce the strength of trades unions? Trades unions do a great deal of harm. I shall give in to no one on that proposition. But is there anyone in Britain who is so naive as to suppose that their strength can be reduced by an incomes policy? Maybe, temporarily, you can reduce the real wage that one union, or another, gets but only temporarily. People who use this argument for an incomes policy are fooling themselves. Most of them, of course, are really unwilling to come out flatly and say: It would be socially desirable to reduce the strength of trades unions. But they are willing to argue for a policy that makes no sense at all, unless it has that effect. Face up to the issue squarely. If you want to reduce the strength of trade unions, by all means take measures to do so. If you don t, then accept that the strong unions will get higher real wages than the weak unions. Cairncross: Can we follow what you were saying earlier about indexing wages? Friedman: The argument for indexing wages is primarily that it will make it easier to slow down inflation. It works like this. If a business man agrees on a wage bargain with his workers when, on both sides, they expect a 10 per cent inflation, then actual inflation turns out to be 6 per cent, the real wages he pays are higher than he had thought he was going to have to pay. He, therefore, has to reduce his production to adjust to this higher wage. If wages are indexed, then his real wage bill will be what he expected. So the case for indexing is that it reduces the side effects the costs of slowing down inflation. Cairncross: What about indexing Government securities? Friedman: Sheer simple morality requires that. Almost all of the people who have bought Government securities in the past have been cheated, as the interest they have received has been more than eroded by the inflation that has occurred. It is the very Government that benefits by 3
fleecing the lambs that produce the inflation that fleeces them. That s an utterly immoral and intolerable situation. Cairncross: What about taxes? Friedman: That is also partly a moral case. Parliament should vote the taxes that you bear. With inflation, you are subjected to taxes that no Member of Parliament would ever have voted for. You could not have got through Parliament taxes on low and middle incomes as high as the taxes that are now imposed on people because inflation has automatically pushed them up into higher brackets. There s a second argument for indexing taxes. Cairncross: What s that? Friedman: It reduces the incentive for a Government to inflate. If taxes are indexed, the hidden tax of inflation will still yield a return to Government but it will be much smaller. A third argument for indexing taxes is that it reduces the disruptions inflation causes in industry. With inflation, taxes tend to fall on capital instead of on the return from capital. This discourages investment, discourages the efficient use of capital, and so makes it much harder to slow down inflation. Cairncross: To sum up, then, how should a country set about curing inflation? Friedman: There is only one cure for inflation, and only the Government can effect it: by slowing down its own spending and by slowing down monetary growth, which will reduce private spending. There is no way of slowing down inflation that will not involve a transitory increase in unemployment, and a transitory reduction in the rate of growth of output. But these costs are far less than the costs that will be incurred by permitting the disease of inflation to rage unchecked. If you permit that, you will destroy civilisation as we know it. The pain of transition, though, can be reduced by administering sedatives. Cairncross: What do you mean? Friedman: First, you must impose your cure gradually. Slow down the rate of Government spending and of monetary growth gradually, so that you don t impose a severe shock upon the economy. The second, and I think the most urgent sedative, is indexing. Third, be sure that you have an adequate welfare system and provision both for the short-term and the long-term unemployed, to help people who are hurt in the process of adjustment. Beyond that, the urgent need is to have a public opinion that will support you. Inflation is an old, old disease. We ve had thousands of years of experience of it. There is nothing simpler than stopping an inflation from the technical point of view. The real problem is to engender the political will that will back a policy to end inflation. Cairncross: How does the US measure up to this prescription? Friedman: Almost nothing has happened so far. 4
Cairncross: But the Federal Reserve has been pursuing a tight money policy. Friedman: Not at all. You must distinguish talk from action. Interest rates have been very high, but they have been high because money has been easy. The rate of growth of the money supply in the US has been roughly constant for three years. For the past two, or three months, the rate has shown some decline. Similar temporary declines have occurred several times in the past. So, while I very much hope this is the real beginning of a period of relatively slow monetary growth, the statistics do not yet confirm that such a change has happened. Cairncross: What about Britain? Friedman: In the last two years, the rate of growth of your quantity of money has been so rapid that it has not yet been absorbed in spending. The quantity of money for each unit of output has risen very substantially, compared with the price level. So I would try to bring the rate of monetary growth to a lower level a sharply lower level than prevailed in the last two years. But I would not in any way try to offset the very low rates of growth of the last six or eight months. I think you can probably regard those as having simply absorbed the excess liquidity built up in the last couple of years. 5